Global: BOJ Policymaker Hints at Rate Hike if Yen’s Impact on Inflation is Significant

The Bank of Japan (BOJ) may consider raising interest rates if sharp declines in the yen lead to higher inflation or significantly alter public expectations of future prices, according to board member Seiji Adachi. Speaking on Wednesday, Adachi indicated that while short-term currency fluctuations alone wouldn’t prompt a policy shift, persistent and excessive yen depreciation that heavily influences inflation expectations could trigger a rate hike.

In his speech, Adachi emphasized the need for the BOJ to assess not only downside risks to the economy and prices but also potential upside risks in shaping its policy direction.

“We must by all means avoid raising interest rates prematurely. However, an overemphasis on downside risks could result in accelerating inflation, forcing us to tighten monetary policy more aggressively later on,” Adachi said. “As long as underlying inflation continues to trend toward 2%, it’s important to gradually adjust the degree of monetary support based on economic, price, and financial developments,” he added, hinting at the possibility of a near-term rate hike.

Adachi’s remarks underscore the increasing importance of the yen’s weakness in determining the timing of the BOJ’s next interest rate hike, which some analysts predict could happen as soon as July.

Despite Adachi’s comments, the yen weakened to its lowest level in four weeks against the dollar due to rising U.S. yields. The dollar peaked at 157.41 yen before settling at 157.10 on Wednesday.

Adachi projected that consumer inflation will re-accelerate from summer through autumn due to rising import costs and sustained wage gains. “If yen falls accelerate or persist, consumer inflation may rebound sooner than expected. Should this coincide with a higher likelihood of inflation exceeding 2% durably and stably, we may need to advance the timing of an interest rate hike,” Adachi stated.

Ideally, Adachi suggested, the BOJ would raise rates gradually in alignment with steady increases in underlying inflation. He shared these insights during a news conference following his speech to business leaders in Kumamoto, southern Japan.

The yen has depreciated by roughly 10% against the dollar this year, despite the BOJ’s decision in March to end eight years of negative rates, as market focus remained on the significant divergence between U.S. and Japanese interest rates.

This yen weakness has posed challenges for policymakers concerned about the impact of rising import costs on consumption, leading some market participants to speculate on a near-term rate hike to curb the currency’s depreciation.

A Cabinet Office survey revealed that Japan’s consumer sentiment worsened for the second consecutive month in May, affected by rising prices. The government revised its assessment of consumer sentiment, noting that “improvements were stalling” compared to the previous month’s view that it was improving.

No Steering in Rate Hike, Taper Timing

Expectations of a near-term rate hike pushed Japan’s 10-year government bond yield to 1.07% on Wednesday, the highest since December 2011. Some traders also speculated that the BOJ might initiate a full-fledged tapering of bond purchases next month, following an unexpected reduction in bond buying on May 13.

Adachi mentioned that the BOJ would eventually reduce its bond purchases, aligning with its March decision to end a policy that capped bond yields around zero. However, he clarified that the May 13 bond buying reduction had no policy implication and it was too early to determine if recent rises in Japanese long-term yields would be sustained.

“I don’t have a strong view on whether the BOJ should reduce bond buying soon or wait longer,” Adachi said, adding that the bank had no preset schedule or idea regarding the future pace of tapering. He emphasized that any reduction in bond purchases would be gradual to avoid market destabilization.

BOJ Governor Kazuo Ueda has stated that the central bank intends to hike rates to levels neutral to the economy, as long as growth and inflation align with projections. Ueda also mentioned that the BOJ will eventually cease using bond purchases as a monetary policy tool and reduce the size of its substantial balance sheet.